How should investors interpret historical market data? Possibly the best advice comes from Nobel Laureate and Stanford Professor William Sharpe who wrote

"Although it is always perilous to assume that the future will be like the past, it is at least instructive to find out what the past was like."

"While results vary from asset class to asset class and from time period to time period, experience suggests that for predicting future values, historic data appear to be quite useful with respect to standard deviations, reasonably useful for correlations, and virtually useless for expected returns. For the latter, at least, other approaches are a must."

"... there is a well known tendency for future risks and correlations to be more like those of the recent past than like those of the distant past."

Investors should note that many experts recommend making adjustments to some long term historical returns for a better comparison to current and projected returns. Some recommended adjustments include replacing the average historical bill/bond return with the current yield on the appropriate treasury security and adjusting the historical interest rates upward to account for interest rates being pegged at artificially low levels in the 1940's and early 50's. An alternative method of analyzing returns is to start with the treasury security return (the risk free rate) and add risk premiums for other investments. From this perspective, changes in interest rates affect returns on all other investments. Another problem with the long term numbers is that there are no comparable figures for some asset classes (international, venture capital, real estate) for the entire period.

While the historical data makes for a very persuasive argument for investing in stocks (small stocks in particular), it can also be used to show the volatility and risks inherent in short term investing. There have been many periods when returns have been inconsistent with long term figures. Here are some examples.

Venture Capital from 81 to 91 had negative returns despite being one of the best long term investments.

Japanese stocks have done extremely well since world war II, but since peaking in 1989 returns have been negative.

If you look at the Ibbotson long-term graph of stocks and small stocks, you'll see that despite the fact that small stocks outperformed for the entire time frame, from 1926 until the mid 1960s, large stocks and small stocks had similar returns. See also the The Size Effect (or myth?).